Aug. 17 (Bloomberg) -- Eastern Europe, whose banks are the
world’s most dependent on foreign funding, may benefit in the
long term from a pullback by western lenders as economic
imbalances abate to leave a sturdier platform for growth.

Credit in the region is stagnating, according to the
European Bank for Reconstruction and Development. While that’s
weighing on economic expansion, it’s also closing budget and
current-account deficits, trimming foreign debt, nurturing local
deposit markets and safeguarding against bubbles.

“The balance sheets of the economies will be much
cleaner,” Kieran Curtis, who helps oversee $4.5 billion in
emerging-market debt at Aviva Investors Ltd. in London, said in
an Aug. 2 phone interview. “Growth with moderate credit growth
stands a better chance of being more balanced.”

Foreign lenders such as Italy’s UniCredit SpA and Austria’s
Erste Group Bank AG dominate eastern Europe’s banking industry
with three quarters of assets. Investors have fretted that a
retrenchment by western banks, which the International Monetary
Fund says supercharged eastern nations’ economic growth to the
tune of 1.5 percentage points a year until 2008, will hijack the
region’s recovery from recession.

The cost of insuring Hungarian and Polish state debt
against non-payment for five years using credit-default swaps
has risen to 437 and 163 basis points from 378 and 144 at the
start of last year, data compiled by Bloomberg show. A basis
point is 0.01 percentage point.

Nordics, Asia

Eastern Europe isn’t the first region that’s had to deal
with a credit shock. Financial-industry deregulation sparked a
Nordic lending bubble that burst in the early 1990s, while
inflows of foreign capital to Asia stoked property and equity
prices before a crash in 1997.

Both regions suffered recessions in the aftermath. Even so,
some economies went on to grow for a decade or more as Swedish
household debt shrank to about 80 percent of disposable income
in 1995 from 140 percent in 1990, according to the central bank,
and Thai imports plummeted, turning a 1996 trade deficit of $16
billion into a $2.5 billion surplus in five years.

Nordic governments including Sweden’s improved fiscal
discipline as they exited their crises, according to a January
report by the McKinsey Global Institute, which said this was a
prerequisite for economic growth.

Budget Limits

The European Union’s eastern members are following suit,
with all of them planning to post fiscal shortfalls within the
27-nation bloc’s limit of 3 percent of economic output this year
or next. Among measures deployed, Poland has overhauled its
pension system and Latvia has raised sales taxes.

Deleveraging can be a good thing, as long as the process is
“gradual” and “orderly,” according to a June 13 blog post by
Bas Bakker, head of the IMF’s emerging Europe division, and
Christoph Klingen, his deputy.

Benefits include a fall in external debt, which would lower
financing requirements and make currencies more stable, Bakker
said in a July 12 interview in Vienna.

Polish government and private debt owed to foreigners was
262.7 billion euros March 31, up from 173.7 billion at end-2008.
Romanian external debt rose to 98.7 billion euros from 72.4
billion over the same period, while Hungary’s advanced to 129.9
billion euros from 123.5 billion euros.

External Deficits

The western European credit inflows that stopped in 2008
helped widen current-account deficits, the broadest measure of
trade. While Hungary’s gap reached 7.8 billion euros that year,
the country has posted a surplus each quarter starting from the
second three months of 2009.

Eastern European banks increasingly rely on locally sourced
savings to fund lending, with the region’s average ratio of
loans to deposits dropping to 101 percent in February from 120
percent in January 2009, Raiffeisen Bank International AG said
in a June report. The indicator fell in Poland, Hungary and
Bulgaria, Raiffeisen’s data show.

“The crisis taught us that what was going on before wasn’t
sustainable,” Gianni Papa, head of UniCredit’s eastern European
business, said in a July 27 phone interview. “We have to switch
to a different model.”

Slower credit growth is positive for eastern Europe,
according to Papa. Government restrictions on foreign-currency
lending will help lower demand by pushing borrowers toward more
expensive local-currency loans, making economies healthier and
guarding against asset bubbles, he said.

Credit Surge

Before Lehman Brothers Holdings Inc. collapsed in 2008,
eastern Europe’s economies were growing an average of 5 percent
a year, while credit was surging as much as 40 percent in Poland
and Romania, UniCredit data show. Foreign inflows have since
reversed as western lenders sell assets and bolster capital to
meet tighter regulatory requirements.

The pullback is adding to concern that economic growth is
under threat as the euro region’s debt crisis hampers demand for
goods manufactured in the continent’s east. GDP growth in
central Europe and the Baltics will average 1.7 percent this
year, down from 3.5 percent in 2011, the EBRD forecast July 25.
Southeastern Europe will expand 0.7 percent, less than a third
of last year’s pace, while Croatia, Hungary and Slovenia will
suffer recessions, the bank predicts.

‘Wreak Havoc’

Since mid-2011, funding withdrawals from eastern Europe
have reached “worrisome levels,” according to the Vienna
Initiative, a group of global lenders, regulators and policy
makers that rallied to help keep the region’s banking industry
afloat after 2008. A fast-paced unwinding would “wreak havoc”
on the region’s economies and threatens financial stability
should the euro region’s debt crisis worsen, it warned July 20.

Foreign banks withdrew the equivalent of 0.7 percent of
gross domestic product from eastern Europe in the third quarter
of 2011 and 0.4 percent in the fourth, the group estimates.
While the pace eased to 0.2 percent of GDP in the first quarter,
it’s probably “picked up” since, it said.

Credit after inflation in May contracted 16 percent in
Hungary, 15 percent in Latvia and 8 percent in Lithuania from a
year earlier. It grew 3.9 percent in Poland and less than 1.5
percent in Bulgaria and Romania, EBRD data show.

While the pace of deleveraging is largely out of the
region’s control as developments in the euro-area crisis dictate
banks’ actions, a return to pre-crisis growth rates would be
ill-advised and isn’t on the cards, according to Lucian
Croitoru, an adviser to Romanian central bank Governor Mugur
Isarescu.

“The banking system has learned a lesson and they’ve
become more prudent,” he said in an Aug. 3 phone interview.
“Of course we need credit to help our economy but it’s much
better for it to be slower, much slower.”